The Obamacare Subsidy Cliff

 

I am looking at a case involving the premium tax credit.

We are talking about the Affordable Care Act, also known as Obamacare.

Obamacare uses mathematical tripwires in its definitions. That is not surprising, as one must define “affordable,” determine a “subsidy,” and - for our discussion – calculate a subsidy phase-out. Affordable is defined as cost remaining below a certain percentage of household income. Think of someone with extremely high income - Elon Musk, for example. I anticipate that just about everything is affordable to him.

COMMENT: Technically the subsidy is referred to as the “advance premium tax credit.” For brevity, we will call it the subsidy.

There is a particular calculation, however, that is brutal. It is referred to as the “cliff,” and you do not want to be anywhere near it.

One approaches the cliff by receiving the subsidy. Let’s say that your premium would be $1,400 monthly but based on expected income you qualify for a subsidy of $1,000. Based on those numbers your out-of-pocket cost would be $400 a month.

Notice that I used the word “expected.” When determining your 2022 subsidy, for example, you would use your 2022 income. That creates a problem, as you will not know your 2022 income until 2023, when you file your tax return. A rational alternative would be to use the prior year’s (that is, 2021’s) income, but that was a bridge too far for Congress. Instead, you are to estimate your 2022 income. What if you estimate too high or too low? There would be an accounting (that is, a “true up”) when you file your 2022 tax return.

I get it. If you guessed too high, you should have been entitled to a larger subsidy. That true-up would go on your return and increase your refund. Good times.

What if it went the other way, however? You guessed too low and should have received a smaller subsidy. Again, the true-up would go on your tax return. It would reduce your refund. You might even owe. Bad times.

Let’s introduce another concept.

ACA posited that health insurance was affordable if one made enough money. While a priori truth, that generalization was unworkable. “Enough money” was defined as 400% of the poverty level.

Below 400% one could receive a subsidy (of some amount). Above 400% one would receive no subsidy.

Let’s recap:

(1)  One could receive a subsidy if one’s income was below 400% of the poverty level.

(2)  One guessed one’s income when the subsidy amount was initially determined.

(3)  One would true-up the subsidy when filing one’s tax return.

Let’s set the trap:

(1)  You estimated your income too low and received a subsidy.

(2)  Your actual income was above 400% of the poverty level.

(3)  You therefore were not entitled to any subsidy.

Trap: you must repay the excess subsidy.

That 400% - as you can guess – is the cliff we mentioned earlier.

Let’s look at the Powell case.

Robert Powell and Svetlana Iakovenko (the Powells) received a subsidy for 2017.

They also claimed a long-term capital loss deduction of $123,822.

Taking that big loss into account, they thought they were entitled to an additional subsidy of $636.

Problem.

Capital losses do not work that way. Capital losses are allowed to offset capital losses dollar-for-dollar. Once that happens, capital losses can only offset another $3,000 of other income.

COMMENT: That $3,000 limit has been in the tax Code since before I started college. Considering that I am close to 40 years of practice, that number is laughably obsolete.

The IRS caught the error and sent the Powells a notice.

The IRS notice increased their income to over 400% and resulted in a subsidy overpayment of $17,652. The IRS wanted to know how the Powells preferred to repay that amount.

The Powells – understandably stunned – played one of the best gambits I have ever read. Let’s read the instructions to the tax form:

We then turn to the text of Schedule D, line 21, for the 2017 tax year, which states as follows:

         If line 16 is a loss, enter ... the smaller of:

·      The loss on line 16 or

·      $3,000

So?

The Powells pointed out that a loss of $123,822 is (technically) smaller than a loss of $3,000. Following the literal instructions, they were entitled to the $123,822 loss.

It is an incorrect reading, of course, and the Powells did not have a chance of winning. Still, the thinking is so outside-the-box that I give them kudos.

Yep, the Powells went over the cliff. It hurt.

Note that the Powell’s year was 2017.

Let’s go forward.

The American Rescue Plan eliminated any subsidy repayment for 2020.

COVID year. I understand.

The subsidy was reinstated for 2021 and 2022, but there was a twist. The cliff was replaced with a gradual slope; that is, the subsidy would decline as income increased. Yes, you would have to repay, but it would not be that in-your-face 100% repayment because you hit the cliff.

Makes sense.

What about 2023?

Let’s go to new tax law. The ironically named Inflation Reduction Act extended the slope-versus-cliff relief through 2025.

OK.

Congress of course just kicked the can down the road, as the cliff will return in 2026.

Our case this time was Robert Lester Powell and Svetlana Alekseevna Iakovenko v Commissioner, T.C. Summary Opinion 2002-19.

It’s A Cliff, Not A Slope

It is one of my least favorite areas of individual tax practice.

We are talking about health insurance. More specifically, health insurance purchased through the exchanges, coupled with advance payment of the premiums.

Why?

Because there is a nasty tax trap in there, and I saw the trap again the other day. It caught a client who gets by, but who is hardly in a position to service heavy tax debt.

Let’s set it up.

You can purchase health insurance in the private market or from government-sponsored marketplaces – also called exchanges. The exchanges were created under the Affordable Care Act, more colloquially known as Obamacare.

If you purchase health insurance through the exchange and your income is below a certain level, you can receive government assistance in paying the insurance premiums. Make very little income, for example, and it is possible that the insurance will be free to you. Make a little more and you will be expected to contribute to your own upkeep. Make too much and you are eliminated from the discussion altogether.

The trap has to do with the dividing line of “too much.”

Let’s look at the Abrego case.

Mr and Mrs Abrego lived in California. For 2015 he was a driver for disabled individuals, and he also prepared a few tax returns (between 20 and 30) every year. Mrs Abrego was a housekeeper.

They enrolled in the California exchange. They also did the following:

(1)  They provided an estimate of their income for 2015. Remember, the final subsidy is ultimately based on their 2015 income, which will not be known until 2016. While it is possible that someone would purchase health insurance, pay for it out-of-pocket and eventually get reimbursed by the IRS when filing their 2015 tax return in 2016, it is far more likely that someone will estimate their 2015 income to then estimate their subsidy. One would use the estimated subsidy to offset the very real monthly premiums. Makes sense, as long as all those estimated numbers come in as expected.

(2)  They picked a policy. The monthly premiums were $1,029.

(3)  The exchange cranked their expected 2015 numbers and determined that they could personally pay $108 per month.

(4)  The difference - $ 1,029 minus $108 = $921– was their monthly subsidy.

The Abregos kept this up for 10 months. Their total 2015 subsidy was $9,210 ($921 times 12).

Since the Abregos received a subsidy, they had to file a tax return. One reason is to compare actual numbers to the estimated numbers. If they guessed low on income, they would have to pay back some of the subsidy. If they guessed high, the government would owe them for underestimating the subsidy.

The Abregos filed their 2015 return.

They reported $63,332 of household income.

How much subsidy should they have received?

There is the rub.

The subsidy changes as income climbs. The subsidy gets to zero when one hits 400% of the poverty line.

What was the poverty line in California for 2015?

$15,730 for a married couple.

Four times the poverty line was $62,920.

They reported $63,332.

Which is more than $62,920.

By $412.

They have to pay back the subsidy.

How much do they have to pay back?

All of it - $9,210.

Folks, the tax rate on that last $412 is astronomical.

It is frustrating to see this fact pattern play out. The odds of a heads-up from the client while someone can still do something are – by the way – zero. That leaves retroactive tax planning, whose success rate is also pretty close to zero.

Our client left no room to maneuver. Why did her income go up? Because she sold something. Why did she not call CTG galactic command before selling – you know: just in case? What would we have done? Probably advised her to NOT SELL in the same year she is receiving a government subsidy.

How did it turn out for the Abregos?

They should have been toast, except for one thing.

Remember that he prepared tax returns. He did that on the side, meaning that he had a gig going. He was self-employed.

He got to claim business deductions.

And he had forgotten one.

How much was it?

$662.

It got their income below the magic $69,920 level.

They were on the sliding scale to pay back some of that subsidy. Some - not all.

It was a rare victory in this area.

Our case for the homegamers was Abrego v Commissioner.

Repaying The Health Care Subsidy

Twice in a couple of weeks I have heard:

“They should check on the Exchange.”

The Exchange refers to the health insurance marketplace.

In both cases we were discussing someone who is between jobs.         

The idea, of course, is to get the subsidy … as someone is unemployed and can use it.

There might also be a tax trap here.

When you apply for Obamacare, you provide an estimate of your income for the coverage year. The answer is intuitive if you are applying for 2020 (as we are not in 2020 yet), but it could also happen if you go in during the coverage year. Say you are laid-off in July. You know your income through July, and you are guessing what it might be for the rest of the year.

So what?

There is a big what.

Receive a subsidy and you have to pay it back – every penny of it – if your income exceeds 400% of the poverty line for your state.

Accountants refer to this as a “cliff.” Get to that last dollar of income and your marginal tax rate goes stratospheric.

Four times the poverty rate for a single person in Kentucky is approximately $50 grand.  Have your income come in at $50 grand and a dollar and you have to repay the entire subsidy.

It can hurt.

How much latitude does a tax preparer have?

Not much. I suppose if we are close we might talk about making a deductible IRA contribution, or selling stock at a loss, or ….

There may be more latitude if one is self-employed. Perhaps one could double-down on the depreciation, or recount the inventory, or ….

Massoud and Ziba Fanaieyan got themselves into this predicament.

The Fanaieyans lived in California. He was retired and owned several rental properties. She worked as a hairstylist.

They received over $15,000 in subsidies for their 2015 tax year.

Four times the California poverty line was $97,000.

They reported adjusted gross income of $100,767.

And there was (what I consider) a fatal preparation mistake. They failed to include Form 8962, which is the tax form that reconciles the subsidy received to the subsidy to which one was actually entitled based on income reported on the tax return.

The IRS sent a letter asking for the Form 8962.

The Fanaieyans realized their mistake.

Folks, for the most part tax planning is not a retroactive exercise. Their hands were tied.

Except ….

Mr. Fanaieyan remembered that book he was writing. All right, it was his sister’s book, but he was involved too. He had paid some expenses in 2012 and 2013. Oh, and he had advanced his sister $1,500 in 2015.

He had given up the dream of publishing in 2015. Surely, he could now write-off those expenses. No point carrying them any longer. The dream was gone.

They amended their 2015 tax return for a book publishing loss.

The IRS looked at them like they had three eyes each.

To Court they went.

There were technical issues that we will not dive into. For example, as a cash-basis taxpayer, didn’t they have to deduct those expenses back in 2012 and 2013? And was it really a business, or did they have a (dreaded) hobby loss? Was it even a loss, or were they making a gift to his sister?

The Court bounced the deduction. They had several grounds to do so, and so they did.

The Fanaieyans had income over four times the poverty level.

They had to repay the advance subsidies.

I cannot help but wonder how this would have turned out if they had claimed the same loss on their originally-filed return AND included a properly-completed Form 8962.  

Failing to include the 8962 meant that someone was going to look at the file.

Amending the return also meant that someone was going to look at the file.

Too many looks.

How Will You Report The ObamaCare Subsidy On Your Tax Return?

It is called the “premium assistance tax credit,” and it refers to the subsidy that people will receive under the ObamaCare individual mandate. It will begin in 2014, and it is supposed to make insurance more affordable for people under 400% of the federal poverty line (FPL). I am not really sure how the politicians came up with 400%, as many if not most of us would agree that 4 times the poverty line is nowhere near poverty. For example, if you are married and have a child, 400% of the FPL is $78,120. That picks up a lot, if not the majority, of people in the Cincinnati area. 

OBSERVATION: I did not realize that Washington views the average Cincinnatian as impoverished and in need of their help.  How did we ever survive this blight before?

Starting next year, you have to address your health insurance, either by receiving it through work, remaining on your parent’s policy, buying it in the private marketplace or on the public exchange. If you don’t, tax advisors are supposed to calculate a tax penalty when preparing your 2014 taxes in April 2015. If you do, then tax advisors may have to go through a separate calculation to determine whether the government paid too much or too little subsidy toward your health insurance. As a tax advisor, I say … whoopee. You would think the government could at least put me on its 401(k) plan for doing its yeoman work.

So how do you calculate whether the government paid too much or too little? That is our topic this week.

We will need two tables to do this. The first is the FPL table by household size.

The second table provides the phase-out of the subsidy as one’s income increases through the FPL table.

When you and I meet in April 2015, I will know your 2014 adjusted gross income (AGI), which starts off this exercise. A good definition of AGI is the amount of money you made before you deduct your house, taxes, contributions and kids. I will then have to make some adjustments to it, if you have certain items on your return:

·        I will add tax -exempt interest

·        I will add the untaxed portion of your social security

·        If you worked overseas I will add the exempted portion of your salary

You now have something called modified adjusted gross income (MAGI).

Let’s say that you are married, have a toddler and your MAGI is $55,000. You have a modest home, an older car and are living the dream. 

The table tells me that you are under 400% of the FPL (which is $78,120 for a family of 3), so we next talk about your health insurance. You tell me that you do not have insurance at work. Your wife is staying at home and being a mom. You went and bought a health policy on the public exchange. You purchased an Anthem bronze plan costing $715 per month. That $715 however was before the subsidy, to which we will return in a moment.

We now have your actual 2014 income, and we have to settle-up with the government. If you were under-subsidized, you will get a check. If you were over-subsidized, you have to return the money. 

NOTE: The subsidy is being paid directly to the insurer. You never see this check. It is very possible that you never even paid attention to the subsidy amount, as you were focusing only on your out-of-pocket.

At MAGI of $55,000, you are at 282% of the FPL ($55,000/$19,530). We now go to the next table. There is a sliding scale between 250% and 300% FPL, going from 8.05% to 9.5% of MAGI. You are somewhere in the middle, so we have to do some math:

            282 – 250 = 32

            32/50 = 64%

            9.5% - 8.05% = 1.45%

            1.45% * 64% = 0.93%

            8.05% + 0.93% = 8.98%

Your premiums are limited to 8.98% of your MAGI. As we said, your income was $55,000. That means your share of the premiums caps-out at $4,939.

How much was your subsidy? Total annual premiums were $8,580 ($715 * 12 months). Your cap is $4,939. The difference is $3,641, or $303 per month. If your subsidy was less than $303/month, I have good news for you. If it was more, then I have bad news, as you will be writing the government a check.  How do we know the subsidy? There will be a new tax form – Form 1095-A- that will be issued about the same time as your W-2. You will have to bring that form to me when preparing your taxes.

There are limits on how much you have to repay the government:

·        If you are below 200% of the FPL, the most you have to pay back is $600

·        Between 200% and 300% the maximum is $1,500

·        Between 300% and 400% the maximum is $2,500

The $600/$1,500/$2,500 limits are for a family. It is one-half that amount if you are single.

By the way …. IF your MAGI exceeds 400% FPL, then you have to repay ALL the subsidy with your tax return.

The above limits ($600/$1,500/$2,500) do not apply if the government owes you. This could happen if your income dropped significantly, such as your employer moving you to part-time.

You may have read that the White House delayed the employer reporting for one year. It will now start in 2015 (for 2014), rather than 2014 (for 2013). The White House believes that it has limited the potential for fraud because of the requirement to settle-up the individual mandate when filing the individual income tax return. You can see their point.

I am very uncomfortable with this action, however. Since when does a White House get to decide which laws it wants to enforce and which laws it does not? What if the next president decides to “suspend” the corporate tax for a year? This White House is creating precedence for that White House to do so.

What we have now are three categories of health consumers:

(1) Over 400%: you pay full boat. The exchanges and subsidies mean nothing to you.

(2) Between 133% and 400% of the FPL: you may be subject to the above, depending upon your insurance situation at work.

(3) Below 133%: you are likely enrolled in Medicaid and pay no premiums at all. This however will vary by state, as many states did not participate in the Medicaid expansion under ObamaCare.

You cannot deduct the portion of your health insurance that is being subsidized. However, since the medical deduction threshold is increasing to 10% (from 7.5%) of AGI, it is highly unlikely that you will ever deduct medical expenses again, unless you have exceptional circumstances. 

And there is how the government intends that people will settle up their ObamaCare if they qualify for a subsidy. Seems reasonable, as in I-haven’t-been-in-the-real-world-and-earned-a-real-paycheck-for-many-years-now and how-hard-can-it-be-to-build-a-website sort of way.

After all, what could possibly go wrong?